Is your magic number one million dollars, two million dollars, or five hundred thousand dollars? It really depends on six primary factors. These six factors, depending on how they relate to you, will either mean you have to save more or less to be comfortable in retirement. Let’s go through each of these factors one at a time.

Pension income sources

There still are Canadians who have company pension plans. The best ones are defined benefit pensions. These are the ones where the company guarantees a monthly income to you in retirement for the rest of your life. Defined contribution plans are pretty much just like an RSP. Thing is, not all defined benefit pension plans are as secure as others. There have been lots of examples, Nortel being one of them, where pensioners are not getting what they have been promised.

Nortel pensions will only receive 57.1% of their pension.

Sears Canada might be heading in the same direction.

Canada Pension Plan (CPP) is in much better shape, and old age security benefits (OAS) appears solid for those eligible.

From a retirement savings standpoint, the more pension income you have from all of these sourcesthe less you need to save.

Retirement duration

How long is your retirement phase going to be? Plainly, the earlier you retire and stop having earned income, the more money you are going to need to draw from for the rest of your life. Is your retirement period going to be 20 years, 30 years, longer? The longer it is, the bigger that nest egg needs to be.

Investment rate of return

The growth of your savings matters. The higher the rate of return on your investments, the less you need to accumulate through your retirement saving years. The lower the investment return, the more you are going to have to beef up that retirement nest egg. If only it was possible to know in advance what your returns are going to be. Future returns are unknowable. So be careful to use conservative return assumptions in your planning. Over-estimating future returns will result in under saving pre-retirement increases the risk of outliving your money while in retirement.

Retirement spending

A comfortable retirement means different things to different people. If your style of living in retirement will cost $100,000 dollars a year, you're going to need to save a lot more than someone who is comfortable living on $40,000 dollars a year. Knowing what your future lifestyle spend is going to be is an important thing to consider.

Housing

Are you a homeowner? If so, you have another asset that can support you in retirement, perhaps in your later years, once you have spent through your savings. If there are no other assets for you to fall back on, your financial nest egg will need to be larger than someone who has that real estate. A property will help you to the degree that is not mortgaged. The value of the real estate is only the equity in it.

Legacy

An estate legacy can be money and/or assets left for your children, other people who are important to you, and charity falls into that category as well. If you have a magic number in your mind that represents the legacy that you want to leave behind, those are assets you will not use during your lifetime. The bigger your desired legacy, the larger the required nest egg.

Make sure that you and your financial planner take all of these factors into consideration when determining your magic number!

This information is of a general nature and should not be considered professional advice. Its accuracy or completeness is not guaranteed and Queensbury Strategies Inc. assumes no responsibility or liability.

Then I ask which one they’re concerned about, and what they’re basing that determination on.

They say: Well, that’s what the statement says. That’s what I’m looking at!

But statements can be misleading. Let me explain why.

We’ll begin with industry jargon

Let’s first deal with some industry jargon. You may have heard of adjusted cost of your investment, or something called book value. These two terms mean the same thing.

Market value is what your investment is worth today. It is not the same as book value and/or cost.

What typically happens in these cases is that an investor is comparing their adjusted cost to market value, as reported on their statement. They look at the difference between those two, and say that that is the performance they are generating.

In other words, they’re thinking market value, less my book value, is my percentage return.

But! Book value, and what’s called net invested – essentially the money you put in – are not the same thing.

Your percentage return is what you put in, versus your market value.

A deeper look at book value

Let’s figure it out – what is book value? If it isn’t what you invested, then what is it?

This is important because book value, and adjusted cost base, are reported on your statement. Plus market value.

So where is your net invested?

It usually doesn’t show up at all!

Then what is book value all about? Book value, or adjusted cost base, equals net invested plus income distributions. Let’s talk about those income distributions!

Income distributions change everything

The investment that you bought, say a mutual fund, owns a number of types of investments. Those investments generate interest if they’re bonds. They might pay dividend income, if they’re stocks, and if sold at a profit they will generate capital gains. If you own that investment in a taxable account? The CRA says: Give me my tax money.

This income will have to be reported and will show up on one of those lovely T-slips at the end of the year even if you reinvested the income rather than took it in cash. But you don’t want to pay tax on that return twice!

So let’s assume the investment unit value that you bought was $10 per share, and you got an income distribution of $1 per share. If at the end of the year the unit value was $11 dollars per share, you reinvested that $1 – you didn’t take it out. You’re going to pay tax on that $1. So your book value is now your net invested plus this one dollar of income. Now your book value is 11 dollars. It’s not what you originally invested! It’s what you invested plus any income distributions.

Tax implications

Now, one day you might sell this investment.

You invested at 10 dollars, you got a 1 dollar income distribution on which you paid tax, it’s worth 11 dollars and you sell it. You’ve made 10 percent! Pretty good!

But you shouldn’t be made to pay tax on that $1 again, so the CRA calculates your capital gain on this investment as the market value minus the book value, which was 10 dollars plus your income distribution: $11. So you have zero capital gain. Hooray!

Bet you never thought you’d be happy about not having a capital gain on an investment! But you should be happy – you don’t want to pay tax on this income twice.

RRSP and TFSA statements

The next question I hear is: Why does this get reported on my RRSP or TFSA statement, when taxes don’t come into play? The distributions are not taxable.

The fact is, financial institutions usually use one system to report all account information. What’s useful for a tax account may not be as useful for a tax-free account but everything gets reported the same way.

Moral of the story

The next time you’re thinking of judging the quality of your investment return by comparing cost base to market value? Don’t do it – you’ll be missing part of the puzzle!

This information is of a general nature and should not be considered professional advice. Its accuracy or completeness is not guaranteed and Queensbury Strategies Inc.assumes no responsibility or liability.

July 2017

The investigation began in 2014. It concluded, with remarkable speed and efficiency, in 2016.

As a result, major Canadian banks and investment institutions repaid hundreds of millions to customers across the country. Based on years of overcharging.

The OSC (Ontario Securities Commission) has a newish no-contest settlement that allows cases to be settled without an admission of wrongdoing – no surprise that in each case, the institutions “neither admitted nor denied the accuracy of the facts and conclusions” of the OSC staff!

The cases included settlements with the Bank of Nova Scotia, the CIBC, TD Bank, the mutual-fund giant CI Investments, and Quadrus Investment Services Ltd.

What are our major institutions saying?

What did our major financial institutions call these multi-million-dollar settlements?

“Excess fees not detected in a timely manner” (RBC)

“Inadequacies” in system controls and controls and supervision (CIBC)

“Inadequacies” in payment systems (Manulife Securities)

Call it whatever you want. If you were one of the thousands of clients who were overcharged (and have been or will be refunded the excess fees), do you think it’s time to reconsider your advisory relationship?

But why penalize the advisor? Isn’t it the fault of the institution?

Because they know they were overcharging you. And if they suggest they were unaware, it’s either an untruth or an admission of ongoing poor service.

Here’s why.

The bulk of the overcharging was related to fee-based accounts. These are accounts where the negotiated advisory fee is charged at an account level, rather than at the product level.

Prior to an account becoming “fee-based,” clients would pay by product – through trade commissions when buying stocks and bonds, and through trailer fees embedded in mutual funds. But once an account becomes fee-based, clients pay a fee based on the size and nature of their account.

What happened in most of these cases is that an account holding full-fee mutual funds became a “fee-based” account. At that point, the full-fee mutual fund was not switched into one that excluded trailer fees. That resulted in a layering (or a lathering??) of additional fees. Which means you the investor were paying your original full fee, plus the new fee for being a fee-based account.

Here’s a simple parallel

Say you’re a member of a fitness club who pays a fee every time you get out on the court. Racquets buff that you are, fired up by Raonic’s rise to fame, you decide one day to become an all-inclusive member.

Now, you’re paying one annual fee that covers as many or as few games as you can manage.

But! Somehow, the fitness club doesn’t notice that you’ve switched payment systems. It continues to charge you for court fees every time you play.

They also, of course, charge you the new all-inclusive fee. For years. Using fee statements that are surprisingly difficult to comprehend.

Not only that, this ongoing ‘problem’ occurs at most major fitness clubs across the country.

To cap it off, the reason you went over to the all-inclusive fee in the first place was at the counsel of your fitness advisor, who gets a percentage of every full-fee, as well as every court fee. Last but not least, you have learned that the management of these ‘fitness clubs’ (you can read my blog on this here) pressure the ‘fitness advisors’ hard to sell as many ‘fitness packages’ as they can, regardless of customer fit (no pun intended ;-).

Was it an accident?

Any advisor that did not understand how they were compensated is a stretch and a half. Here’s a question for you – what do you think would have happened in the reverse situation? If, when an advisor’s client had switched to fee-based, a mistake had occurred such that they received neither trailer nor fees? Would they have noticed then?

At the end of the day, though, I don’t think it matters if you think it was an accident or not.

Any client who was subjected to this double-dipping is the recipient of either dishonesty or appalling sloppiness. Maybe it’s time to look for a more ethical, diligent, trustworthy advisor.

Rona Birenbaum is a certified financial planner and founder of Caring for Clients. This information is of a general nature and should not be considered professional advice. Its accuracy or completeness is not guaranteed and Queensbury Strategies Inc.assumes no responsibility or liability.

"If you can get your hands on a directory of doctors, you'll be made." Believe it or not, this was part of my training as a rookie financial adviser over 20 years ago when cold-calling, door-knocking and investment seminars were the primary methods of finding new clients. The pressure to bring in new assets was intense, so focusing prospecting efforts on the perceived wealthy was an obvious route.

If you are a high income earning doctor, lawyer, C-suite executive or successful business owner, you probably know that you are a target, not just of the financial services industry, but of others as well.

The method of getting your attention and creating doubt about your current service providers may have changed over the years, but you are still more heavily prospected than almost any other demographic.

A quick Internet search on prospecting doctors generated the following gems:

"Power Prospecting - Get in front of Physician Prospects in 28 days!"

From a Canadian industry magazine, on why one adviser prospects younger doctors: "It's better to catch them before they have their own lawyers and accountants. A physician in her 50s, for instance, probably has a solid relationship with an adivser, and she'll only move if something market- or service-related breaks that relationship.":

"7 Ways to Prospect Doctors"

In a list of the top six niches financial advisors should target, "occupations" is number two, and the author specifically recommends doctors and lawyers.

Extra Vigilance

OK, so I've hopefully made the case that you are a hot commodity, So why does it matter?

I think it means that you need to be extra vigilant when being approached by someone from the financial industry (even if that person was me!). Anectdotally, highly taxed professionals are generalized as being particularly vulnerable to pitches of "creative" tax reduction schemes and products exclusive to the "high net worth" individual. Appeal to their ego, I've been told many times. Show them something not widely available to get their attention.

Sigh. I'm sorry to tell you that extra vigilance takes energy. But it takes a lot more energy to unwind a strategy or relationship that wasn't well-suited to begin with.

What does vigilance look like?

Do not respond to product-only pitches. This is the sign of a salesperson, not an adviser.

If you meet with an adviser and their product idea is compelling, run it past trusted sources such as your accountant, lawyer and financial planner, if you have one.

Seek advice from independent sources not recommending proprietary solutions. These solutions may not be in your best interest and are rather a way for salespeople to maximize their income and the financial institution's profit margins.

Trust your gut. If it seems too good to be true, or just doesn't feel right, avoid it.

Process not product

Now, here is why I happen to enjoy working with physicians, lawyers, corporate executives and business owners.

They're busy. They're tired. They just want to spend more time with their family. They want to know that one day, all the hard work will pay off with some degree of financial security. Frankly, everyone wants these things.

It's important for you to know that the panacea is not a product. It is a process. A journey, not unlike the one that you take with your customers, patients, employees and corporate stakeholders.

The essence of the process looks like this:

Understand your uniqueness and history.

Flesh out how you define financial health/success.

Develop a well thought out, evidence-based plan to get you there.

Support and encourage you on your journey.

Repeat annually, more frequently as necessary, forever.

So really, for some of us in the industry, we're not that different from you. Apply the vigilance I recommend to finding these kindred spirits. You'll be wealthier as a result.

Replublished from The Medical Post - with permission

Rona Birenbaum is a certified financial planner and ounder of Caring for Clients. This information is of a general nature and should not be considered professional advice. Its accuracy or completeness is not guaranteed and Queensbury Strategies Inc.assumes no responsibility or liability.

My daughter was 11 at the time. She turns 18 next month and will be heading to university in the fall.

I’m feeling a bit nostalgic, a bit weepy (I may as well admit it) and in awe of the passage of time. So I’m bringing back the original post with an update on how things have evolved, and some ideas about what an allowance is and is not.

Should you give your child an allowance?

I was having coffee with a friend recently who has three beautiful daughters age 6 and under. She asked me when I began giving my soon-to-be 11 year old daughter Rachel an allowance.

Now, there are many philosophies on the subject, and sharing my own is not meant to be prescriptive. I do find, however, that people tend to be interested in my personal money decisions, given that I give so many people financial advice (yes, I practice what I preach!).

My daughter started getting a weekly allowance about 3 months ago. Here is how it happened:

I was preparing dinner after work and she was doing her homework at the kitchen table. Out of the blue she said, “Mom, when can I get an allowance?”

Me: “Why do you ask?”

Daughter: “Well, my friends get an allowance.” (bad answer)

Me: “What would you spend an allowance on?”

Daughter: “Hmmmm, well, birthday presents and Mother’s Day and Father’s Day presents. Stuff like that (good answer!). And I will do chores around the house.”

Me: Rachel, your responsibilities at home are yours whether or not you get an allowance. Everyone in the family pitches in, even though we don’t get paid for it. That will not change. Dad and I will discuss this and let you know.

We did discuss it, and neither of us have anything against giving Rachel an allowance. She has learned the value of money over the years and when she has received gifts in the form of cash, she hands over most of it for her savings account. So, having a little spending money for presents etc. will get her used to making buying decisions.

We surveyed a number of parents and found out that the going rate within her group of friends is $5. Wow, when I was a kid it was 50 cents! But back then, I could buy two chocolate bars for 50 cents.

So, how is it going? Pretty well I think! She has made a couple of purchases, but has also been saving. Just this weekend she mentioned that she is saving up for a laptop. Good thing they get less expensive every day!!!

2017 update

What did she first use her allowance for?

Yes, she did buy that laptop – second-hand and within her small budget. She was very pruod of her purchase and used it daily.

She did purchase small gifts for me, her dad and some of her friends to celebrate birthdays and seasonal holidays.

Then what?

Her allowance increased slightly over the years, then disappeared completely when she got her first summer job at age 16.

Savings from the summer job in hand, her required contribution to the “extras” increased:

She contributed 1/3 of the cost of her Apple IPhone.

She buys clothing items that are beyond the “necessary” (from her parents’ perspective).

She goes out with friends occasionally for Korean BBQ, Thai etc., and uses her own money.

How about her savings, and university costs?

I just handed over the birthday money she gave me to save for a number of years. She can handle it now.

She’s looking forward to the $2000 university scholarship offered to her (Calculus final grade permitting!).

And today?

She is heading into university with lots of savings in the bank, a sense of control over money and priorities, and a growing nest egg that will help her establish herself in her first apartment in second year university.

Yes, we could have paid for everything on top of providing an allowance but I don’t think that would have helped Rachel understand:

The value of a dollar

The benefit of delaying gratification

How money grows when invested

How money allows for independence and choice.

We did good. And so did Rachel.

This information of a general nature and should not be considered specific advice, as each reader's personal financial situation is unique and fact specific. Please contact your financial advisor or Caring for Clients prior to implementing or acting upon any of the information contained herein.

By now, most of you working with a financial advisor or robo-advisor have completed a standard risk tolerance questionnaire. You know the questions:

How much of a percentage decline in your portfolio can you tolerate over the short term?

How soon will you been needing the money you plan to invest?

How old are you?

Is your objective safety, income or growth?

But do these questions adequately assess your risk tolerance?

I don’t think so.

Here’s a simple example. Recently, a client answered that she would be comfortable with a 10% decline in the value of her portfolio. I then asked her if she could tolerate a $100,000 decline in portfolio value and she was far less enthusiastic. I pointed out that as her portfolio value was $1 million, $100,000 and 10% were for her the same thing. It was an eye-opener.

How do you actually behave as an investor?

At Queensbury Strategies, in addition to the typical risk tolerance and investor profile questions, we have started asking a few others, ones that provide a more accurate measure of our clients’ true risk tolerance. Such as:

During the 2008/2009 financial crisis did you:

Sell any investments that had declined in value?

Hold onto your investments through the decline?

Add to your investments through the decline?

Contribute to retirement savings but leave the money in cash temporarily until the market settled down?

How much of a decline could you handle in dollar terms before you would begin questioning your investment strategy?

Quality investments designed to generate higher than GIC returns can experience temporary declines in value. What do you consider short-term?

1 month

6 months

1 year

2 years

During a recent conversation with consumer advocate and personal finance expert, Ellen Roseman, Ellen suggested another illuminating question that I plan to integrate:

Actions speak louder than words

In other words?

Your real attitude towards risk is best measured by what you do, not what you think. Or what you think you think!

Get your risk tolerance right – it matters

The historical underperformance investors have experienced is largely due to a misalignment of their portfolio and their risk tolerance. That misalignment results in poor decision-making, particularly during times of market stress and market euphoria.* It even shows up in investment flows in mutual funds and ETFs.**

Getting your risk tolerance right when structuring your portfolio is Job One. As you were reading, did you ask yourself the questions I asked in this blog? Do you think that you and your investor would change your estimation of your risk tolerance, knowing these answers?

“The information contained herein was obtained from sources believed to be reliable. Its accuracy or completeness is not guaranteed and Queensbury Strategies Inc. assumes no responsibility or liability”

Many of you will have read my March post, discussing the furor over TD bank employees being caught breaking the law. You may remember I was unsurprised. Bank employees being pressured to sell unnecessary products? That’s been a feature of the banking industry for as long as I’ve known it.

In a recent visit to LinkedIn, I ran into another example of this issue.

LinkedIn ­postings for financial planners – how much is about planning?

Whenever I visit LinkedIn, the platform tries to recruit me for positions they think suit my skills – typically, financial planner roles. The last time I went, I decided to actually look; I needed a break during a demanding day.

My eyes began to widen as I read. The financial planners the banks are looking for bear little relation to the candidates I’m looking for.

When I’m looking to add a new planner, I post on the Financial Planners Standards Council website; it’s where I found my last four. As I read the bank postings, I pulled out my posting, and started to check off the differences.

I began to see why most Financial Planner candidates tell me their job search is not going well. They are looking to help clients save appropriately and prepare for retirement, while the jobs postings with the Financial Planner title are actually aggressive sales roles.

A few examples – let’s start with job objectives and motivation

Following, a few excerpts from the Caring for Clients job posting on overall goals:

To support us in being … the leading fee-for-service financial planning firm in Toronto, responsible for delivering value-added planning services and ongoing support

Retaining clients so we are the last financial advisor clients will ever need

Delighting clients with every touch point.

Now, a couple of excerpts from the banks’ postings on objectives and motivation:

Your creativity, motivation, and hunger to drive new investment sales is what pushes you to provide world-class advice

The FP will identify opportunities to refer clients to bank partners, i.e. Retail and Wealth Management

Moving forward, let’s talk responsibilities

Here’s how the Caring for Clients job posting describes responsibilities of a planner:

Collect and analyze client financial and non-financial information

Prepare multiple planning scenarios using specialized software

Identify the actions need to achieve client goals and support and empower the client.

Sounds a lot like financial planning, right? But the banks have a different idea:

Focused on the mass affluent customer segment with responsibilities for retaining and increasing market share through acquisition of Money-in assets.

Develop external business referral sources through networking, marketing, and your centres of influence

Need to succeed qualities

Here’s the first line from each in the “need to succeed” category:

Us: Minimum 3 years experience in client-facing financial services role

Bank: Proven networking and client acquisition skills

And our conclusion is?

This isn’t solely about financial planning.

In Canada, we have a tendency to view banks and bank employees as courteous, impartial, and supportive. When we enter a branch to deal with minor or major financial matters, we typically accept their suggestions, sometimes without questioning. We notice they tend to leap when they see a chance to talk about investments, or if we have more than the usual amount in our chequing account, but we don’t pay much attention to it.

But! If this sounds like you, I recommend you be more wary. Each branch has metrics (aka sales objectives) assigned from head office; these are passed down to the individuals who work there – hence the furor at TD. Those courteous employees are trained and pressured to find opportunities to sell.

If you’re looking for a financial planner – an individual who reviews and analyzes all your financial data, then helps you set spending and saving goals, and offers support and counsel to help you meet those goals – your bank may not be the best place to start.

This information of a general nature and should not be considered specific advice, as each reader's personal financial situation is unique and fact specific. Please contact your financial advisor or Caring for Clients prior to implementing or acting upon any of the information contained herein.

A “job for life” is a thing of the past. Most Canadians will receive a termination notice at least once in their career. Don’t leave getting the best possible treatment in your severance to chance. If you are hesitating getting legal advice before signing on the dotted line, consider the following:

1.The termination agreement is an offer, often up for negotiation. There very well be more money and protection available to you, but only if you ask. The request should come in the form of a legal letter from an experienced employment lawyer. The letter infers that you mean business and infers the potential cost of litigation which can motivate the employer to offer better terms.

2.The cost of legal advice is tax deductible. Legal fees paid to collect money owed to you for severance, pension benefits, or a retiring allowance are deductible on your tax return under “Other Deductions”. Keep in mind that your fees can’t be reimbursed by your employer and the amount collected must be considered income. For example, if your entire severance was transferred to an RRSP, the legal fees are not deductible that year. You can carry the deduction forward for 7 years though to deduct against other income. *

3.Ask for financial planning – A career interruption is the perfect time for a comprehensive financial plan. A planning engagement will help you manage through a period of unemployment and help you assess a range of employment options you may want to consider.

4.Insurance benefits are important – Ensure that your benefits extend along with your period of salary continuance. In most cases, group disability insurance benefits are difficult to negotiate inclusion. Transition disability insurance is designed to fill this specific gap and you can negotiate payment of the premium for such coverage into your termination agreement.

5.You will feel empowered – Job loss, even from a job you disliked, is emotionally draining. Taking control of the severance experience, is a confidence builder. Even if the ultimate terms remain unchanged because they were fair to begin with, you will have taken an important step in protecting your rights.

A termination notice can be upsetting, but if you empower yourself to be treated fairly, you will face the next phase of your career with greater confidence.

*Knowledge Bureau

This information of a general nature and should not be considered specific advice, as each reader's personal financial situation is unique and fact specific. Please contact your financial advisor or Caring for Clients prior to implementing or acting upon any of the information contained herein.

Typically, severance packages do not include a continuation of disability insurance. This, despite the courts having made clear* that an employer is obligated to continue all benefits during the common law notice period, in the absence of a contract stating otherwise!

But should a severed employee become permanently disabled during their notice period, the cost to the employer can easily run into the hundreds of thousands of dollars, if not millions. It’s a considerable risk.

Why is this obligation so often ignored in severance packages? I see three primary reasons. The employer:

Is not aware of the legal obligation.

Has not considered the financial exposure.

Lacks a simple, cost-effective solution to fulfil their legal obligations.

If you’ve received a termination notice and the disability obligation has been ignored, you need to negotiate a transition disability policy as part of your severance package.

What is a transition disability policy?

A transition disability policy:

Provides individual coverage for a period of 6-24 months (typically, equal to your severance period).

Is designed to pay disability benefits that start 90 days after a severance and continue to age 60 or 65.

Includes coverage for both accident and sickness, and offers monthly benefits of up to $10,000 (actual amount depends on final base salary).

Why can’t I just get regular disability insurance?

Disability insurance is, technically, income replacement insurance. No income? No coverage. (While there are a handful of disability policies that don’t require earned income, they are limited in scope.)

It could be some time before you have a stable income upon which an individual policy would be justified. And if you make the leap to self-employment, it could take a few years before you have a track record of proven income upon which a new insurance company would provide coverage.

Is everyone eligible?

You may qualify if you:

Are age 60 or younger

Have been at work full time at full pay for 12 or more months

Apply for this coverage within 90 days of your last day at work

What’s the process?

The application includes a few medical questions. The insurer may require additional information from your physician before making a decision on whether to issue the policy.

There is a one-time premium, which makes it simple to negotiate into a severance package. We provide this cost to clients that have been terminated, so they can request the cost be included in their final compensation.

In summary

Disability insurance is one of the most important aspects of a group health and dental plan. You don’t want to be without it.

When your severance package includes a continuation of benefits, but excludes disability, get a quote for Transition Disability coverage. Then pass it on to your ex-employer with this article.

1 [2006] O.J. No. 34 (C.A.).Egan v Alcatel Canada Inc.

This information of a general nature. Please contact your financial advisor or Caring for Clients prior to implementing or acting upon any of the information contained herein. Its accuracy or completeness is not guaranteed and Queensbury Strategies Inc. assumes no responsibility or liability.

Interest rates are still low. As a result, we are increasingly asked if it makes more sense to invest extra cash rather than pay down debt. The same question comes up when we recommend using non-registered investments to pay down debt.

You might be thinking:

“If my mortgage rate is under 3%, wouldn’t I be better off investing extra cash and pocketing the difference?”

Maybe.

Let’s assume for the moment that leveraged investing is appropriate for you – because that’s what you would be doing. Further on, I’ll give you a checklist to determine if you really are a candidate for leveraged investing.

Let’s try an example

To start, let me challenge your assumption with a little math. We’ll assume you have $100,000 that you now want to invest, and you also have:

The results

In this case, the choice of investing vs paying down the mortgage earns an extra 1.3% per year (4.2% - 2.9%). Note that if the portfolio return had a greater component of interest, taxes paid would be higher, decreasing the 1.3% advantage to investing that this case shows.

Of course, you could achieve a higher return on your investments, but you could also experience a lower, or negative return in the short term. In addition, you’ll want to pay the tax out of your bank account rather than withdrawing from your investment portfolio. Using your portfolio to pay taxes reduces the magical advantages of compound growth over time.

How do you stack the numbers in your favour?

Here are three ways to optimize your choices:

Let the tax act help you. CRA lets you deduct your borrowing costs (interest charged) when you borrow to invest in an income generating investment. Note that the paper trail is important to qualify for the deduction. In our example, you would need to take the $100K cash and pay down your debt first, then borrow it back and invest in the portfolio. You must be able to prove that the borrowed funds were used to make the eligible investment.

Invest tax-efficiently. The less taxable income the portfolio generates the better.

Invest for growth. The higher return the better. Conservative fixed income won’t generate the returns you need to make this work, and is tax-inefficient to boot.

Checklist for leveraged investing

So, is this for you? Here’s the checklist I promised earlier, to decide whether you are a candidate for leveraged investing. See how many you say yes to!

You are investing for the long term.

You have a stable income and can afford to pay the annual loan interest and taxes on portfolio income from your cash flow rather than the portfolio.

You will not have future borrowing needs. The leveraged strategy could impede your ability to borrow additional funds for other purposes.

You have a high risk tolerance. This is necessary for two reasons:

A growth portfolio is necessary to generate the necessary return to compensate for the risk of the overall strategy.
Aborting the strategy during a bear market amplifies your losses. There is a loss on the investment as well as the outstanding debt that cannot be fully repaid when the strategy is unwound.

How did you do?

What can go wrong?

You’re a knowledgeable investor; before you make your choice, you want to review the downside as well. Here are the two eventualities most likely to derail a leveraged investing plan:

Interest rates rise - rising loan interest rates and a stock market correction would be a bad combination. Historically, rising interest rates signal the end of an economic cycle, and precede a recessionary period, which is negative for the stock market.

You need to liquidate the portfolio at an inopportune time. There are lots of reasons why you might need the cash. Job loss, supporting children or parents unexpectedly, and major house repairs are just some of the events that could force you to liquidate your investment at a time that undermines the leveraged strategy.

Is the risk worth it?

I always like to measure the long-term impact of investing versus debt repayment with a detailed financial planning exercise. You might be surprised to find out that paying down debt is the most effective, certain path towards your wealth-building goals.

But if you answered yes to all of the items in the checklist above, that risk of leveraged investing may be worth it for you. Talk to your advisor!

This information of a general nature and should not be considered professional tax advice.The information contained herein was obtained from sources believed to be reliable. Its accuracy or completeness is not guaranteed and Queensbury Strategies Inc. assumes no responsibility or liability